S&P likes the PC accessory maker's history of strong growth—and its attractively valued stock—and rates the shares strong buy
From Standard & Poor's Equity ResearchWe believe that Logitech International (LOGI; recent price, $35) is well positioned to profit from ongoing global growth in consumer electronics as personal-computer users seek more portability, more functionality, and greater personalization of their PCs. The company offers a broad range of accessories for PCs, including keyboards, pointing devices (mice), Webcams and video aids, audio accessories, and gaming consoles. It recently expanded by acquisition in remote controls.
The company exhibits a number of strong fundamental characteristics, in our view. Relatively consistent and rapid sales growth is one. Management targets long-term annual revenue growth in the mid-teens, which seems credible to us, given a recent historical record of achieving those rates plus our expectation for solid growth for sales of new PCs through 2008. Additionally, we believe the rate of attached sales for peripherals, especially wireless mice for notebook PCs, is likely to increase as the percentage of notebook PCs among new PC sales rises over time.
Attention to research and development to maintain a stream of attractive new products has helped to steady sales, by having new product ready to supersede aging designs, and we see this trend continuing. Other fundamentals we appreciate are Logitech's broad customer base and exposure to many geographic territories around the world.
We believe the shares are undervalued based on our price-to-earnings (p-e) analysis, which examines the company's historical p-e patterns and p-e ratios on information technology companies generally. Overall, we see an attractive growth story available at a compelling valuation, and rank the shares 5 STARS (strong buy).
Logitech is a major provider of computer peripherals and other consumer-electronics products. Founded in 1981 and based in Switzerland, the company has about 7,400 employees. Shares trade on both the SWX Swiss Exchange and Nasdaq Global Select Market. Production operations are global in scope. The company has plants in Switzerland, the Netherlands, California, Taiwan, and China. It leases sales offices in 55 locations in 37 countries, which illustrates the international breadth of the marketing operations.
Products include PC mice, such as the new VX Nano Cordless Laser Mouse; keyboards; trackballs; 3D control devices; Webcams; multimedia speakers; wireless and Internet music solutions; headsets; headphones; gaming controllers; gaming accessories, such as steering wheels; and advanced remote controls for home entertainment systems, including the high-end Harmony 1000 model.
Sales by geographic region for fiscal 2007 (ended March) were derived 50% from Europe, 35% from North America, and 15% from Asia Pacific. We believe the lack of an even balance by region implies that there are opportunities for deeper penetration into prime market territories. Sales are accomplished mainly through retail channels (89% of fiscal 2007 sales), and additionally through original equipment manufacturers (OEMs, 11%). Logitech products are available through major retailers. OEM clients include the major PC makers.
Sales by market segment are as follows—pointing devices, 25%; audio, 20%; keyboards, 18%; video, 15%; gaming, 7%; remote controls, 4%; OEM, 11%. Sales growth was above the company average of 15% for fiscal 2007 for cordless mice, audio, and remote controls.
We believe that sales of cordless mice are being driven by a broad trend toward wireless computing. As consumers increasingly shift to notebook PCs, which typically come without a mouse, and as these are often used at home (rather than on the go) where a good mouse and full-size keyboard can enhance the computing experience, we think consumers are opting to purchase a wireless mouse and other wireless peripherals. Thus, we think the prospects for increased levels of "attached sales" for Logitech improve with the percentage of notebooks in the overall sales mix for new PCs. Of course, peripherals are sold to the installed base of computers, too, as users upgrade and personalize their setup.
Audio accessory sales are rising as more people bring MP3 players and digital music into their lives. Attractions include better music storage, better speakers, and the convenience of wireless functionality.
The company's Harmony brand universal remote controls have been a big hit among consumers seeking to organize an increasingly complex mix of electronics devices around the home.
Overall, the company has an expansive product line, with more than 1,800 stock-keeping units. Most of these products sell for under $100, which makes them attractive for impulse buying and gift-giving. We think the purchase decision on a peripheral item is not particularly daunting. The company aims primarily at "affordable luxury" price points, but typically offers a range of products in a line to service the high and low ends of each market niche.
Looking at Logitech's financials, we see a sturdy structure. The company has no long-term debt, which adds a margin of safety. It pays no dividend, which we view as appropriate for a company in the growth phase of its corporate life cycle. Logitech has been buying back shares recently, which should offer minor support to EPS (earnings per share) results. Cash flow has grown every year since fiscal 1999. We view the company's profitability as superior to most companies and generally improving over time, with return on assets rising to 19.3% for fiscal 2007 from 9.6% for fiscal 2000. Similarly, return on equity has improved to 30.1% for fiscal 2007 from 18.8% for fiscal 2000.
Given our outlook for revenue growth near 15% for fiscal 2008 and for fiscal 2009, with some improvement in margins based on rising volumes and ongoing efficient-improvement efforts, we think Logitech is in good position to increase operating EPS to $1.50 (excluding a one-time loss on short-term investments) in fiscal 2008, and to $1.80 in fiscal 2009. We believe Logitech stock is attractively valued, recently trading near 23 times our fiscal 2008 estimate and 19 times our fiscal 2009 estimate. We think it should trade nearer the top of its historical range of 14 to 26 times over the past three years, given our view of a strong period of PC sales and increased consumer interest in computer peripherals.
Industry Outlook We project that global PC unit sales will rise about 12% in 2007 and about 10% in 2008, representing solid years of growth for the industry. Sales are being driven by the usual need to periodically upgrade to keep pace with processing and memory improvements for computers. Also, new operating systems from Microsoft (MSFT) and Apple (AAPL) are spurring sales.
We expect the sales growth rate for peripherals to outpace the growth rate for new PC sales, given a long-term trend toward more peripherals being sold with each new PC, as the PC mix shifts toward notebook PCs and multimedia-purposed PCs. Also, the peripherals makers can target the large installed base of PCs for sales of peripherals that add a new function or improve an existing function with wireless capability or other improvements.
We view Logitech's growth prospects and valuation as compelling. Revenue growth has been 15% or better in each of the past five years. Growth in EPS for the same period has generally been higher, near 25%, but showed more variability. Thus, our projections for revenue growth of 15% for fiscal 2008 and 15% for fiscal 2009 are in line with a multiyear trend, rather than are representative of a sudden growth spurt. Similarly, in line with recent historical trends, we are estimating operating EPS to increase about 20% in fiscal 2008 and fiscal 2009.
Recently priced at $35 a share, the shares are trading at 20 times our $1.73 calendar-year 2008 EPS estimate. This is nearly in line with the 19.5 times p-e for the information technology-sector companies in the Standard & Poor's 500-stock index and not far above the 17 times p-e on the info tech companies in the S&P MidCap 400 index. We believe a company with consistently superior sales and EPS growth and no long-term debt deserves to trade at more of a premium.
Over the past five years, the average annual high p-e for Logitech has been about 25 times and the average annual low has been near 13.5 times. Given the strong years for the PC industry that we foresee for 2007 and 2008, we think the shares should trade toward the high end of their valuation range. Applying a 25-times multiple to our calendar 2008 EPS estimate, we arrive at our 12-month target price of $43, indicating potential upside of 23% from current levels.
Overall, we have a mixed but generally positive view of Logitech's corporate governance policies. We view favorably the separation of the chairman and CEO positions. The lack of a poison pill is another favorable factor, but the company is incorporated in a country with antitakeover provisions. Insiders and affiliated outsiders have recently been in a majority on the board, which we view negatively, but the board has adequate size and is soon to undergo some changes in membership.
Like many information technology companies, Logitech compensates employees via stock options. The option grants impact on EPS is reported in the income statement, which is helpful, and amounts to about 2¢ per quarter, which appears in line with industry practice. Options have not been repriced in the past three years, which we also view positively.
Risks to our recommendation and target price include potential slowdowns in PC unit sales or in consumer demand for PC peripherals, the appearance of substitute goods such as embedded Webcams, and any failures to transition smoothly from one generation of product to the next or introduce new products effectively. Competition can pose a challenge—Microsoft's recent entry into the video market is an example. We believe a slowdown in the U.S. economy based on slow housing sales poses some risk to the overall pace of technology spending and PC sales.
Even planned leadership transitions can pose risks to strategy execution. The company is planning to move its president and CEO, Guerrino De Luca, up to the chairman's position, effective Jan. 1, 2008. The senior vice-president of worldwide sales and marketing, Gerald Quindlen, will become president and CEO. Logitech co-founder Daniel Borel will cede the chairman's role but remain on the board of directors.
In the second quarter of fiscal 2008, the company booked a loss of about $67 million resulting from the exposure of short-term investments to a level of risk not authorized by senior management. The treasurer responsible has left the company. Logitech booked a gain equivalent to about half the loss in the third quarter, which should mitigate the effects on annual EPS. We view the events as an unusual one-time item that is unlikely to recur, but nevertheless we think the supervision of cash management is an area of risk to be watched.